After what can only be described as a disastrous year for most equity markets, investors have been left bereft of ideas for 2023. The year has started tentatively, with stubborn inflation and corresponding interest rate hikes continuing to dampen thoughts of a rebound. The uncertainty has left both institutional and retail investors wondering when and ultimately where to position their investments. A microcosm of this environment of uncertainty can be found in the cannabis industry, where a series of starts and stops from the US Government has stalled reform at the federal level and halted momentum in the industry. From billion-dollar firms such as Tilray and Curaleaf down to medium-sized and smaller players, cannabis companies are dealing with multiple headwinds and forcing cost-cutting measures such as widespread layoffs.
Massachusetts-based Curaleaf cut 270 jobs in the second half of 2022 and shuttered a facility in Sacramento. Cannabis tech company WM Technology, which operates Weedmaps, cut 25% of its workforce and saw the resignation of two of its executive team. These are but two examples of widespread cost-cutting measures as established firms await further US reform and seek to hold off new players entering the market as individual states continue to open. New York is next up, with regulated adult-use sales set to kick off this year. With the emergence of a large, albeit more regulated, new market to access, established firms will look to hold off new entrants as NY hands out its own licenses.
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Facing an uncertain future in federal regulation and increasing supply leading to lower prices, most industry experts are expecting a period of consolidation. Just as well-positioned real estate firms scoop up properties from competitors unable to make it through market downturns, so too will opportunistic companies in the cannabis industry.
The opportunity to increase market share is there for the taking, but with capital hard to come by in 2023, there is a definite checklist for any company hoping to thrive in the cannabis space as others fail:
Cannabis Investor Checklist Business to business (B to B) operators are more insulated than companies relying solely on selling directly to consumers. With equity capital scarce, debt management is vital to survival. Cash flow positive businesses will inevitably outperform companies attempting to grow while accruing debt. A surprising number of cannabis companies have been run by finance experts looking to cash in on an investment wave. Without experienced industry-specific leadership, these companies have neither the experience nor the stomach to dig in for the long term, and they are failing across the industry. |
LEEF Brands & The Path of Vertical Integration
When Icanic Brands Inc acquired LEEF Holdings in a $120M deal last April, it represented one of the bigger Canadian industry acquisitions. In acquiring LEEF, Icanic was signaling its intent to be one of the consolidators of the cannabis landscape. Fast forward to today, with the new entity- LEEF BRANDS- continuing to solidify itself as a vital part of the cannabis industry, primarily in the US hotbed of California.
The key for LEEF is vertical integration. The company does it all, from manufacturing to white label production and packaging to its own brand development and even emerging cultivation plans. By keeping a hand in each segment of the industry, the company has been able to operate at comparatively low costs, shielding them from rising inflation and competition in the retail space.
B2B: Powering The Leading Brands in California
Recently acquired dispensary, The Leaf, in Palm Desert, California.
Peruse the cereal aisle on your next trip to the supermarket and you’ll see a wide variety of brands from the sugary cereals many kids love to the healthier organic options. Yet take a closer look and you’ll notice that Kellogg’s actually produces most of them itself, regardless of the name on the front of the box. They remain the goliath of the industry by white-labeling cereals for other companies since they can produce it more efficiently and cost-effectively. LEEF is taking a similar approach, merging pharmaceutical grade purification with industry-best extraction and formulation practices. And while no comparison in size or scope can be made to Kellogg’s, the strategy appears to be paying off. The top seven brands in California seem to agree, as all rely on LEEF for edibles and concentrates. These sticky relationships with the biggest brands in California give LEEF a revenue backbone that most companies don’t possess, and it has enabled the company to operate free from non-debenture debt.
This bears repeating.
LEEF is not a debt-ridden cannabis company desperately looking for capital. In fact, expectations by Q2 (or potentially earlier) point toward a cash-flow positive business, making LEEF somewhat of a unicorn in the cannabis industry of 2023. With increased competition and limited capital, companies without vertical integration are left exposed to price fluctuations, which hit the industry hard in 2022. A recent Bloomberg article reported a 13% drop in marijuana price from $10.83 in Q3 2021 to $9.43 in Q3 2022- “the steepest fall ever seen for marijuana in a 12-month period.”
LEEF’s processing facility in Sacramento not only packages products for the leading brands, but it also supports LEEF’s own stable of brands, led by Ganja Gold, the company’s premium, high-end legacy brand, a top ten brand in the pre-roll space. Real Deal Resin is another of its leading in-house brands, and it is with this brand that LEEF has developed a cult following through artistic collaborations, uniting pop culture with pot culture.
To further their retail footprint, LEEF recently completed a strategic acquisition of California dispensary, The Leaf. The all-stock deal, valued at slightly more than $6M, not only gives LEEF an immediate accretive boost to its revenues, but also provides the company with a popular platform to bring Ganja Gold and its other brands directly to consumers. The company is continuing to focus on M&A with a keen eye on some of the brands it currently works with. Add to this a licensing deal with Buddies Brand, another top ten concentrate company in the state, and once can see how indispensable LEEF has become to the industry in California.
True vertical integration in the cannabis industry isn’t complete without cultivation, and LEEF has developed partnerships with more than 200 cultivators in the US. The company is looking to take it one step further, having been awarded a land use permit in Santa Barbara for a 186-acre cannabis cultivation operation. With LEEF’s large manufacturing footprint, there is room to add cultivation as competitors in the industry begin to fail.
Challenges
Achieving vertical integration is all well and good, but it doesn’t fully insulate any company from the storms hitting global markets. LEEF (CSE: LEEF, OTCQB: LEEEF) public stock has fared no better than most of its industry counterparts over the past year. With shares trading at only 1x revenues ($0.08 CDN/share), the stock has fallen 63% in the past year, better than industry average but not by much.
Investors will also be taken aback by the massive share count (over a billion shares). Such a large float of shares is often a red flag for investors, signalling a vicious circle of dilution and underperformance. However, in all fairness to LEEF, this doesn’t appear to be the case. Both their merger last April and the recent acquisition of The Leaf Dispensary were all-share deals. This ballooned the share count from about 200 million to its current state. The good news for shareholders is that the vast majority of the shares are held by insiders, including CEO Micah Anderson, the architect of LEEF’s vertical integration transformation. The executive team, led by Anderson, appears to be all-in, with large share lockups and a long term view. As for Mr. Anderson, he certainly exudes industry experience, as evidenced by his role as a key opinion leader at federal and state levels, where he is a regular speaker and government consultant.
And then there is the industry itself. To assume any cannabis company is going to have a banner year in 2023 borders between hopeful thinking and outright naivety. By all accounts, the industry is going to spend the next year consolidating, which may present excellent long-term investment opportunities but certainly doesn’t serve those looking for immediate satisfaction. For legalized cannabis, the initial boom days are firmly in the rear view mirror and investors should instead be planting the seeds for slower, more lasting growth. The opportunity to catch a big green wave is gone, and now the focus should be on cultivating a basket of safer, well-positioned companies. And while it may seem counterintuitive to consider a microcap company among them, LEEF Brands may well present an opportunity for a profitable long term investment in comparison to its peers.
Oh, and if you’re into the power of celebrity, prominent LEEF shareholders include NBA stars Jimmy Butler and Rudy Gobert. With the soaring popularity of the NBA with Millenials and Gen Z, one might imagine the endorsement opportunities for a certain California cannabis brand.
DISCLAIMER: This article shall not be construed as financial advice & it may be outdated or inaccurate at the time of reading. (i) I am neither an investment adviser nor a broker-dealer; (ii) the information presented in this material is for informational purposes only and is not to be treated as advice or a recommendation to make any specific investment or as a guarantee or prediction of the future value of any specific investment. I have neither a long nor a short position in LEEF Brands, nor any company in the cannabis sector currently.
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